Investors are always searching for ways to protect investments from losses and the eroding effects of inflation. One type of investment that can provide a hedge against inflation when it comes to your investment portfolio is Treasury inflation-protected securities, or TIPS.
But especially in today’s market climate, it’s important to do your research, know the risks and monitor market conditions before making a move. And TIPS are best for a long-term investment strategy, not a short-term fix for exposure to inflation, as many investors have discovered in the last year.
TIPS are Treasury marketable securities that adjust their principal value and interest payments to keep up with inflation. They offer a guaranteed return that beats inflation, making them an attractive option for investors looking to preserve their purchasing power.
[Sign up for stock news with our Invested newsletter.]
However, buying TIPS can be confusing for those who are new to investing, and in today’s uncertain market climate it can be difficult to know when to get in on this buy-and-hold investment. Whether you’re a seasoned investor or just starting to learn, here are some tips on how to invest and buy TIPS in order to protect your investment portfolio against inflation in the long term:
— What are TIPS?
— How are TIPS different from other Treasury investments?
— Pros and cons of investing in TIPS.
— TIPS in today’s market climate.
— How to buy TIPS.
— How to further lower risk.
What Are TIPS?
TIPS are a type of bond issued by the U.S. Treasury Department, and they are designed to provide investors with protection against inflation. One of the key features of TIPS is that their principal value is adjusted based on changes in the Bureau of Labor Statistics-reported consumer price index, or CPI, which measures inflation. As the CPI increases, the principal value of the bond increases, which means that interest payments also increase.
However, if TIPS mature and their principal balance is lower than the original amount invested, investors will still receive the original amount.
TIPS have a fixed interest rate that is paid on the adjusted principal every six months until maturity, and maturity dates can be five, 10 or 30 years. The rate is fixed at auction and is never less than 0.125%. At maturity, the investor receives the adjusted principal value of the bond, which includes any inflation adjustments.
How Are TIPS Different From Other Treasury Investments?
TIPS’ classification as Treasury marketable securities means an investor can transfer these securities to someone else or sell them before they mature. Other investments that fall under this category are Treasury bills, Treasury bonds, and Treasury notes and floating-rate notes.
The main difference between TIPS and other types of Treasury marketable securities is that TIPS provide inflation protection, while other investments, such as Treasury notes and Treasury bonds, don’t have the same cushion. Unlike other Treasury securities, which have principal that is fixed, TIPS’ principal can go up or down over its term. This makes TIPS a good option for investors who are concerned about inflation eroding the value of their investments.
Series I savings bonds also adjust for inflation and have been a hot commodity recently, so investors may find themselves looking at both I bonds and TIPS, and there are some differences. For example, TIPS are marketable and can be bought or sold at auction in the secondary securities market, whereas I bonds are not. With a life span of 30 years and a fixed rate of return, I bonds have accrued interest that is paid at redemption, rather than in semiannual interest payments. However, tax reporting on the interest can also be deferred until redemption. With TIPS, interest payments are subject to federal tax in the year they occur.
TIPS are also different from other types of investments, such as stocks and mutual funds. Stocks, for example, do not provide inflation protection outright, but they offer the potential for higher returns for long-term growth within an investment portfolio. However, stocks also carry more volatility and risk in comparison to TIPS.
[See: What’s the Best Treasury ETF? 7 Options for Investors]
Pros and Cons of Investing in TIPS
When investing in TIPS, there are several advantages and disadvantages you must consider before jumping in.
In addition to inflation hedging and guaranteed face value, an advantage of TIPS is that they are government-backed securities, which are considered safer investments in general when compared with some other investments.
Another advantage is that TIPS can provide a fixed income to investors that is fairly predictable over time. TIPS also have a low correlation to other types of investments, which lowers volatility in a portfolio.
A disadvantage of purchasing TIPS is that they pay a lower interest rate in comparison with corporate and government securities. Another drawback is that federal tax is due every year on the inflation adjustment and interest, although they are exempt from state and local taxes.
Like other bonds, TIPS are somewhat vulnerable to changes in interest rates, as rising rates can cause bonds’ market value to decline. But TIPS often perform better against rising rates than conventional Treasury bonds because of the inflation adjustments to principal. This is only in an environment when rates are rising due to higher inflation, though; in a low- or no-inflation, rising-rate period, TIPS’ prices can fall. Many investors learned in 2022 that TIPS have interest-rate risk, too, and are suited to a long-term investment strategy rather than a short-term solution to high inflation.
According to Fidelity, a bond ladder created to hold TIPS of different life spans to maturity can help lower the risk of interest rate volatility. It can make sense to hold bonds in general in your investment portfolio even when rates are rising, because higher bond yields can offset price declines.
TIPS in Today’s Market Climate
The Federal Reserve’s interest rate-hiking campaign to bring the inflation rate down closer to its 2% target has hit a speed bump lately, with the failure of Silicon Valley Bank and other turmoil in the financial sector, and bond yields took a hit in the days after the news of banks’ troubles erupted.
So, interest rates may continue to rise at a slower rate than they did during the last year. Inflation is moderating, but it’s still at historically high levels, and overall economic conditions are very uncertain now.
David Enna, founder of Tipswatch.com, wrote in a March 23 column that real yields on today’s 10-year TIPS are high based on historical trends. A few days earlier, he said that “as long as 10-year real yields sustain above 1%, they remain attractive as an investment.”
How to Buy TIPS
When purchasing TIPS, it’s best to first seek the counsel of a financial advisor. When you decide the time is right, here are the steps to follow to buy TIPS:
Consider your options. You can buy TIPS through a brokerage or from the Treasury Department’s TreasuryDirect website. You can create an account on TreasuryDirect or choose a brokerage firm to purchase TIPS through a brokerage account.
Select the life span of your TIPS. Choose the maturity you want, from five to 30 years, taking your investment goals and time horizon into consideration.
Determine the amount you want to invest. Iron out the other details of your order, including the amount you want to invest and the price you are willing to pay. The minimum investment for TIPS is $100. However, check with your brokerage about the minimum investment amount, as some brokerages may require a higher minimum.
Some brokerage firms may charge a commission or transaction fee for buying and selling TIPS. TreasuryDirect, on the other hand, does not charge a commission or transaction fee.
Keep tabs on your investments. You can monitor changes in TIPS principal on the daily index ratios page of the TreasuryDirect website.
How to Further Lower Risk
There are several risks you have to consider when investing in TIPS, such as fluctuation in interest rates and erosion of the overall monetary value of your portfolio. As mentioned before, the value of bonds, even TIPS, will decline when interest rates rise. Here are some things you can do:
Diversify. To mitigate risk, one strategy is to hold TIPS as part of a diversified portfolio that includes other types of bonds and stocks.
Invest in TIPS funds. Another strategy is to invest in a TIPS mutual fund or exchange-traded fund, also known as an ETF. This can provide greater diversification and potentially lower the risk posed by interest rate and inflation volatility within the stock market.
Build a TIPS ladder. Investors can also consider laddering their TIPS investments. This involves purchasing TIPS bonds with different maturities, helping to stabilize returns and reduce the impact of interest rate and inflation risks over time.
Takeaway
TIPS are bond investments that can provide some protection against inflation. They offer a fixed-income stream, are considered low-risk, and can be a good option for investors who are concerned about inflation depleting the value of their investment portfolio.
However, TIPS may not offer the same potential for higher returns as other types of securities, such as stocks, and they are subject to fluctuations in interest rates and annual federal taxes.
But if you are looking for a buy-and-hold investment that will provide diversification to balance your returns and risk, investing in TIPS can be a great option.
More from U.S. News
7 Best Bond Funds for Retirement
Why Bond Duration Matters for Investors
5 Apps for Socially Responsible Investing
How to Invest in TIPS: Treasury Inflation-Protected Securities originally appeared on usnews.com
